Budget 2013: What the financial services sector expects

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As the day of presentation of the Union Budget draws closer, it is time for the industry and all stakeholders to reflect on what they expect out of the budget on the taxation front - whether it is specific demands or corrections of anomalies that can help provide a boost to the business sentiments. The financial services sector will play a crucial role in accelerating the pace of growth of the Indian economy from a decade low of 5 per cent. Thus, we take a look at some of the expectations of the financial services sector.

It has been a persistent demand of banks that deduction in respect of provision for NPA, presently capped at prescribed limits be aligned with the NPA provision that banks make under the RBI's prudential norms. Allowance of deduction based on provisioning in the books will ensure that banks are taxed on profits that are similar to their accounting profits.

Further, NBFCs, which have been a significant source of lending, are not permitted to claim such a deduction for provision on NPAs. The benefit of this deduction should also be extended to NBFCs. It may be noted the proposed Direct Taxes Code, 2010 (DTC) provides for such a deduction to NBFCs.

Another perennial issue grappling the financial services sector and which has resulted in significant litigation is the disallowance of expenditure incurred for earning exempt income under section 14A. Though the law does provide certain safeguards on the powers of the assessing officer to disallow the expenditure by invoking the relevant rule, the safeguards have clearly proved ineffective. Clarity on various issues are required such as need for direct nexus of the expenditure incurred for earning of tax free income, right of taxpayer to forego exemption of income to avoid disallowance, whether the term "investment" in the Rule also includes stock in trade, etc.

The amendments brought in the Budget 2012 relating to indirect transfer taxation can potentially lead to multi-level taxation in the FII structure including taxation in the hands of an investor in P-Notes issued by the FII. Thus, the recommendations of the Dr Shome Committee that non-resident investors in the FII should not be taxed and that P-notes should be excluded from the rigor of indirect transfer provisions, should be codified. These are 2 important clarifications that the foreign investor community keenly awaits.

In recent times, private equity (PE) funds have emerged as a key source of capital for entrepreneurs. With the introduction of Alternative Investment Fund (AIF) Regulations, it appears that only Category I AIFs would enjoy a pass-thru status for tax purposes; this creates uncertainties in tax treatment of other AIFs. The pass-thru status should be extended to all the categories of AIFs.

Last year, in a major policy decision, Qualified Foreign Investors (QFIs) were allowed to directly invest in Indian capital markets. However, lack of clarity in taxation has been one of the reasons for a tepid response to the QFI route. Further, the recently released FAQs on taxation of QFIs have not been helpful in resolving the concerns of QFIs since they impose onerous obligations on the depositories in relation to discharge of taxes. Clarity on characterisation of income in the hands of QFI and alignment of tax payment mechanism of QFIs possibly in line with the extant framework for Foreign Institutional Investors will go a long way in boosting the attractiveness of this investment route.

Fiscal clarifications to the financial services sector shall go a long way in strengthening this sector and the Indian economy.

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